Blockchain technology has made digital payments faster and easier than ever, and allowed for the proliferation of new cryptocurrencies for different use cases, with unique traits like decentralization, immutability, pseudonymity, and more. These innovations have demonstrated that global finance is ripe for change – and governments have taken note. Central banks across the globe have already begun remodeling financial systems for the internet age.
How? With central bank digital currencies, or CBDCs.
- What are CBDCs?
- Why create a CBDC?
- CBDC projects today: launches, pilots, and research
- Looking ahead: The future of CBDCs
CBDCs are digital equivalents of fiat currency. Like physical cash, CBDCs are issued by central banks and backed by the full faith and credit of the government. But unlike cash, CBDCs are never printed, creating a need for new minting and exchange systems.
Currently, there are two types of CBDCs: retail and wholesale. Retail CBDCs are designed to be held and exchanged between individuals and businesses, whereas wholesale CBDCs are for financial institutions.
CBDCs vs. cryptocurrencies
CBDCs are similar to and distinct from existing cryptocurrencies. They are paperless, like Bitcoin, and backed by real-world assets, like some stablecoins. However, CBDCs are centralized and government-issued – a stark contrast to decentralized digital currencies intended to mitigate problems characteristic of many traditional financial systems.
A new breed of blockchain
Most countries looking to issue a CBDC will use blockchain technology to do so, but these blockchains will be different from others that have come before. The central banks of Sweden and France, for example, have moved forward with pilots of CBDCs that use permissioned blockchains – a centralized variation on the blockchain technology used by Bitcoin and Ether.
A permissioned blockchain is a distributed ledger with an additional layer of access control. This means that certain actions – such as issuing tokens, validating blocks, or viewing transaction history – can be performed only by certain participants in a network. For CBDCs, this might be the central bank, commercial banks, or payment service providers.
This centralized layer is appealing to bankers who want both the permissioning of traditional payment networks and the cryptographic security of blockchains.
There are many reasons to embrace CBDCs, but plenty of pitfalls, too.
The Benefits of CBDCs
Compared to existing systems, a well-implemented CBDC could be more:
- Economical. Since CBDCs are digital, they would substantially reduce the costs of managing physical cash. Furthermore, blockchain-based technological frameworks could reduce both transaction times and transaction costs to fractions of a second and fractions of a penny, respectively.
- Financially inclusive. In countries with large unbanked populations, CBDCs could provide secure access to savings and credit. Paired with mobile applications and digital identification tools, CBDCs could facilitate more participation in the financial system than ever before.
- Global. With CBDCs, cross-border payments could be made faster, cheaper, and more accessible by reducing the number of intermediaries needed to complete a transaction. However, this depends on the degree of interoperability between CBDCs – international coordination is needed to achieve this effect.
- Programmable. A CBDC could provide a direct channel for central bankers to take actions like modifying interest rates.
- Effective against money laundering. The centralized nature of a CBDC could facilitate the identification and blocking of suspicious transactions. Governments might be able to seize and remove illicit funds from circulation entirely. Currently, blockchain analytics tools such as Chainalysis Reactor and Storyline can help government agencies and private institutions track similar types of transactions and activity on public blockchains.
The inherent role of governments in CBDCs has led some observers to fear that the motivations for building CBDCs are authoritarian in nature. China, the major world economy furthest along on the path to a digital currency, is the most commonly cited country in these criticisms.
Such criticisms are not entirely unfounded. As discussed in our Cryptocurrency and China report, China’s CBDC model could enhance the government’s financial surveillance capabilities substantially. Chinese citizens already lack financial privacy; the digital yuan would make it even easier for the CCP to view citizens’ financial activity and to exclude individuals or businesses from the payment system for any reason. Further, financial data generated by the digital yuan could be combined with other types of data feeding into China’s controversial social credit system. While it’s unclear if or to what degree the CCP will elect to use these capabilities, the digital yuan system makes them a distinct possibility.
In democratic countries, on the other hand, politicians and central bankers are expected to work together with the public to find an approach that both preserves privacy and prevents criminal activity. Due to existing financial regulations for KYC/AML, some speculate that CBDCs will be identity-based, but exceptions to this rule could include accounts with balance caps and transactions under certain amounts.
In addition to the privacy concerns stated above, several economic risks factor into the development of CBDCs. Three of these stand out in particular: the disintermediation of commercial banks, a lack of global interoperability, and the potential weakening of the U.S. dollar.
Firstly, if CBDCs do not incorporate commercial banks into their system designs, they risk depriving banks of their deposit base, thus destabilizing domestic banking systems. CBDC designs have countered this with mechanisms like balance caps and zero-interest deposits.
Secondly, if CBDC development is not internationally coordinated, the effectiveness of both cross-border payments and economic sanctions could be eroded. The SWIFT transaction system presently supports these functions, but without a CBDC equivalent, illicit international transactions could go unmonitored and ordinary cross-border payments could be inefficient. Fortunately, SWIFT has outlined its plan to address these issues as CBDCs develop.
Thirdly, some fear that a protracted roll-out of CBDCs could weaken domestic currencies. This looms especially large in the United States, as the U.S. dollar is the world’s reserve currency. The thinking goes as follows: If other countries can roll out CBDCs first and perform CBDC-to-CBDC exchanges without the U.S. dollar, they may not need to maintain their U.S. dollar holdings.
But Danny Li, a research fellow at the Asia Society Policy Institute, disagrees. Given the stability of the U.S. dollar relative to other currencies, Li observes that even multinational projects like the Belt and Road Initiative have been financed with USD. Li also finds that the most advanced CBDCs – particularly China’s digital yuan – are optimized largely for domestic retail payments, with aims like improving financial inclusion, lowering costs, and eliminating cash. In other words, CBDCs – while rich with economic and technological promise – are unlikely to significantly disrupt the existing financial order.
Today, countries representing over 95 percent of global GDP have begun to explore CBDCs. While most countries are years away from implementation, central banks in Asia, Africa, and the Caribbean have already paved the way.
More than 10 countries have already launched some form of CBDC. This list includes the Bahamas, which introduced its Sand Dollar in October of 2020; nine other Caribbean nations; Cambodia, which unveiled a cross-border, remittance-focused CBDC; and Nigeria, which launched its e-Naira in October of 2021. The Cambodian and most of the Caribbean central banks used blockchain technology for their CBDCs, while Nigeria and Jamaica opted for more conventional database architectures.
Most of the CBDCs launched thus far have been developed for retail purposes, although several Caribbean countries have opted for hybrid retail and wholesale models. Other wholesale CBDCs are developing at a brisk pace in the pilot stage.
Several dozen more countries are currently piloting CBDCs. Among these, partnerships between central banks, commercial banks, and IT consultancies are the most common, and wholesale, cross-border CBDCs are the most advanced.
Retail CBDC pilots
Let’s begin with retail CBDCs. Of these, China’s digital yuan (e-CNY) is the most advanced, with more than 100 billion transactions, or $14 billion, thus far. In other words, it’s already widely used. In January of 2023, the e-CNY was included in cash circulation and used to buy securities for the first time. China’s pilot program now involves 26 major cities and 5.6 million merchants.
The payment system, dubbed DC/EP (Digital Currency/Electronic Payments), is issued by China’s central bank, provided to customers via commercial banks accounts, and managed with a conventional ledger – not a blockchain. Although China launched its pilot in 2019, the e-CNY debuted at the 2022 Beijing Winter Olympics, marking the first large-scale digital currency roll-out.
Sweden, South Korea, Kazakhstan, and several other countries have also completed retail pilots. While most of these pilots were successful, tests were typically performed on a small-scale and without the involvement of commercial banks, which are critical stakeholders in the roll-out of CBDCs. Sweden remedied this by involving banks in later stages of testing, but for other nations piloting retail CBDCs, the path to widespread implementation remains unclear.
Wholesale CBDC pilots
Wholesale CBDCs have been picking up in 2023 with most pilots taking place among advanced economies and across continental borders.
The mBridge project, a cross-border collaboration between Hong Kong, United Arab Emirates (UAE), Thailand, and China’s central banks, has thus far been successful. In 2021, mBridge reported that the prototype platform was able to complete international transfers and foreign exchange operations in seconds as opposed to several days under the existing framework, with the cost of such operations reduced by up to half. More recently, mBridge initiated a real-value transaction test involving 20 commercial banks from four jurisdictions, and the platform facilitated transactions worth more than $22 million in USD.
By the end of 2022, the Monetary Authority of Singapore (MAS) had completed the first phase of “Project Orchid,” its early CBDC testing. MAS determined that a retail CBDC is currently unnecessary, but is researching potential use cases for a wholesale CBDC. Similarly, Saudi Arabia has engaged local banks and fintech companies to explore risks and benefits of CBDCs after the success of “Project Aber.”
List of countries that have launched or piloted CBDCs
- Bahamas (Central Bank of the Bahamas): Sand Dollar, launched October 2020
- Cambodia (National Bank of Cambodia): Bakong, retail, launched October 2020
- Antigua and Barbuda (Eastern Caribbean Central Bank): DCash, launched March 2021
- Grenada (Eastern Caribbean Central Bank): DCash, launched March 2021
- Saint Kitts and Nevis (Eastern Caribbean Central Bank): DCash, launched March 2021
- Saint Lucia (Eastern Caribbean Central Bank): DCash, launched March 2021
- Saint Vincent and the Grenadines (Eastern Caribbean Central Bank): DCash, launched August 2021
- Nigeria (Central Bank of Nigeria): e-Naira, launched October 2021
- Dominica (Eastern Caribbean Central Bank): DCash, launched December 2021
- Montserrat (Eastern Caribbean Central Bank): DCash, launched December 2021
- Anguilla (Eastern Caribbean Central Bank): DCash, launched June 2022
- Jamaica (Bank of Jamaica): Jam-Dex, launched July 2022
- Ghana (Bank of Ghana): e-Cedi
- Sweden (Sveriges Riksbank): e-Krona
- Iran (Central Bank of the Islamic Republic of Iran)
- Kazakhstan (National Bank of Kazakhstan): Digital Tenge
- Russia (Bank of the Russian Federation): Digital Ruble
- South Korea (Bank of Korea)
- Saudi Arabia (Saudi Central Bank)
- United Arab Emirates (Central Bank of the United Arab Emirates)
- Singapore (Monetary Authority of Singapore)
- South Africa (South African Reserve Bank)
- India (Reserve Bank of India): Digital Rupee
- China (People’s Bank of China): e-CNY
- Japan (Bank of Japan): Digital Yen
- Hong Kong (Hong Kong Monetary Authority): e-HKD
- Thailand (Bank of Thailand)
- Australia (Reserve Bank of Australia)
- France (Banque de France)
- Brazil (Banco Central do Brasil): Digital Real
- Uruguay (Central Bank of Uruguay): e-Peso
- Philippines (Bangko Sentral ng Pilipinas)
- Turkey (Central Bank of the Republic of Turkey)
- Norway (Norges Bank)
- Venezuela (Banco Central de Venezuela): Digital Bolivar
- Bahrain (Central Bank of Bahrain)
- Bhutan (Royal Monetary Authority of Bhutan)
Some central banks, unsure of how to proceed, are still weighing the costs, benefits, and risks of creating CBDCs.
In the United States, political considerations still weigh heavily on the debate. In March 2023, Federal Reserve Chair Jerome Powell said of CBDCs, “. . .what we’re doing is experimenting in [a] kind of early stage experimentation. How would this work? Does it work? What’s the best technology? What’s the most efficient?” Similarly, Nellie Lang, the Under Secretary for Domestic Finance, stated that “policymakers are continuing to deliberate about whether to have a CBDC, and if so, what form it would take. The Fed has also emphasized that it would only issue a CBDC with the support of the executive branch and Congress, and more broadly the public.” Other politicians, however, have expressed opposition. For instance, Florida Governor Ron DeSantis recently announced legislation against a CBDC, claiming that such a project would promote government surveillance and control.
In the meantime, American universities, financial institutions, and IT consultancies are innovating. MIT’s Digital Currency Initiative studies the implementation of CBDCs and other blockchain-based technologies. The Digital Dollar Project, formed by the Digital Dollar Foundation and Accenture, focuses on CBDC research in the private sector.
Other countries’ explorations with CBDCs are also worth following. The European Central Bank (ECB) recently released an update on the digital euro project, emphasizing the importance of maintaining users’ trust and financial stability, and complementing cash rather than replacing it. England is exploring a digital pound, Colombia is researching a CBDC to reduce tax evasion, and the Central Bank of Kenya published a paper on CBDCs to spark policy discussions.
Is the United States’ FedNow service a CBDC?
The United States Federal Reserve recently announced plans to launch its FedNow service in July of 2023. The goal of this initiative is to provide American financial institutions with instant payment services to boost efficiency and safety of national transactions. Although FedNow will be an accessible, electronic network, it will not involve the creation or deployment of a digital dollar. Many have speculated that FedNow is the government’s substitute for a CBDC, whereas others believe that, if successfully implemented, FedNow could eventually facilitate the integration of a CBDC.
The benefits of CBDCs are manifold: lower-cost transactions, higher-speed settlements, and other improvements in the ways in which billions of people pay. While most CBDCs may be years away, research is moving at a brisk pace. Countries that have already launched CBDCs or are well on their way to implementation will likely influence future research and supportive frameworks as central banks around the world continue to experiment with rapid-paced technological advancements.
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